Firm-Specific Cost Savings and Market Power

We report a policy experiment that illustrates a potential problem of using historical pass-through rates as a means of predicting the competitive consequences of projected firmspecific cost savings in antitrust contexts, particularly in merger analysis. The effects of cost savings on welfare can vary vastly, depending on how the savings affect the industry supply schedule. In a capacity-constrained price-setting oligopoly, we observe that cost savings can overwhelm behaviorally salient market power incentives when the savings affect marginal (high cost) units. However, cost savings of the same magnitude on an infra-marginal unit leave market power unchanged. Financial assistance from the National Science Foundation (SBR 93-19842) is gratefully acknowledged. We thank without implicating an anonymous referee, Tim Cason, Signe-Mary McKernan, Stan Reynolds, Bradley Ruffle, Chuck Thomas, and seminar participants at North Carolina State University, Virginia Commonwealth University, and the 1998 Regional Economic Science Association meetings. The data and a sample copy of the instructions are available upon request from the authors.